ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited Consolidated Financial Statements and related notes above.
CAUTIONARY STATEMENT
CONCERNING FORWARD-LOOKING STATEMENTS
This discussion and analysis contains some “forward-looking statements.” Forward-looking statements concern possible or assumed future results of operations, including descriptions of our business strategies and customer relationships. These statements often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “seek,” “will,” “may” or similar expressions. These statements are based on assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors that we believe are appropriate in these circumstances.
As you read and consider this discussion and analysis, you should not place undue reliance on any forward-looking statements. You should understand that these statements involve substantial risk and uncertainty and are not guarantees of future performance or results. They depend on many factors that are discussed further in the sections entitled (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2022, as supplemented by disclosures in Item 1A of Part II below. Changes or developments in any of these areas could affect our financial results or results of operations and could cause actual results to differ materially from those contemplated in the forward-looking statements.
All forward-looking statements speak only as of the date of this report or the documents incorporated by reference, as the case may be. We do not undertake any duty to update any of these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.
OVERVIEW
We are a leader in the research, development and commercialization of organic light emitting diode (OLED) technologies and materials for use in display applications, such as mobile phones, televisions, monitors, wearables, tablets, portable media devices, notebook computers, personal computers and automotive applications, as well as specialty and general lighting products. Since 1994, we have been engaged and expect to continue to be primarily engaged, in funding and performing research and development activities relating to OLED technologies and materials, and commercializing these technologies and materials. We derive our revenue primarily from the following:
•sales of OLED materials for evaluation, development and commercial manufacturing;
•intellectual property and technology licensing;
•technology development and support, including third-party collaboration efforts and providing support to third parties for commercialization of their OLED products; and
•contract research services in the areas of chemical materials synthesis research, development and commercialization for non-OLED applications.
Material sales relate to our sale of OLED materials for incorporation into our customers’ commercial OLED products or for their OLED development and evaluation activities. Material sales are generally recognized at the time title passes, which is typically at the time of shipment or at the time of delivery, depending upon the contractual agreement between the parties.
We receive license and royalty payments under certain commercial, development and technology evaluation agreements, some of which are non-refundable advances. These payments may include royalty and license fees made pursuant to license agreements and also license fees included as part of certain commercial supply agreements. These payments are included in the estimate of total contract consideration by customer and recognized as revenue over the contract term based on material units sold at the estimated per unit fee over the life of the contract.
On December 2, 2022, we entered into a commercial patent license agreement with Samsung Display Co., Ltd. (SDC), replacing a previous license agreement that had been in place since 2018. This agreement, which covers the manufacture and sale of specified OLED display materials, was effective as of January 1, 2023 and lasts through the end of 2027 with an additional two-year extension option for SDC. Under this agreement, we are being paid a license fee, which includes quarterly and annual payments over the agreement
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term of five years. The agreement conveys to SDC the non-exclusive right to use certain of our intellectual property assets for a limited period of time that is less than the estimated life of the assets.
At the same time that we entered into the current commercial license agreement with SDC, we also entered into a material purchase agreement with SDC, which lasts for the same term as the license agreement and is subject to the same extension option. This new material purchase agreement replaced a previous purchase agreement that had been in place since 2018. Under the material purchase agreement, SDC agrees to purchase from us a minimum amount of red and green phosphorescent emitter materials for use in the manufacture of licensed products. This minimum commitment is subject to SDC’s requirements for phosphorescent emitter materials and our ability to meet these requirements over the term of the supplemental agreement.
In 2015, we entered into an OLED patent license agreement and an OLED commercial supply agreement with LG Display Co., Ltd. (LG Display), which were effective as of January 1, 2015. The terms of these agreements were extended by a January 1, 2021 amendment through the end of 2025. The patent license agreement provides LG Display a non-exclusive, royalty bearing portfolio license to make and sell OLED displays under our patent portfolio. The patent license calls for license fees, prepaid royalties and running royalties on licensed products. The OLED commercial supply agreement provides for the sales of materials for use by LG Display, which may include phosphorescent emitters and host materials. The agreements provide for certain other minimum obligations relating to the volume of material sales anticipated over the life of the agreements as well as minimum royalty revenue.
In 2016, we entered into long-term, multi-year OLED patent license and material purchase agreements with Tianma Micro-electronics Co., Ltd. (Tianma). Under the license agreement, we have granted Tianma non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. The license agreement calls for license fees and running royalties on Tianma’s sales of licensed products. Additionally, we supply phosphorescent OLED materials to Tianma for use in its licensed products. In 2021, we mutually agreed to extend the terms of both the patent license and material purchase agreements for an additional multi-year term.
In 2017, we entered into long-term, multi-year agreements with BOE Technology Group Co., Ltd. (BOE). Under these agreements, we have granted BOE non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. We also supply phosphorescent OLED materials to BOE for use in its licensed products.
In 2018, we entered into long-term, multi-year OLED patent license and material purchase agreements with Visionox Technology, Inc. (Visionox). Under the license agreement, we have granted certain of Visionox’s affiliates non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. The license agreement calls for license fees and running royalties on licensed products. Additionally, we supply phosphorescent OLED materials to Visionox for use in its licensed products. In 2021, we announced an extension of the Visionox agreement by entering into new five-year OLED material supply and license agreements with a new affiliate of Visionox, Visionox Hefei Technology Co. Ltd.
In 2019, we entered into an evaluation and commercial supply relationship with Wuhan China Star Optoelectronics Semiconductor Display Technology Co., Ltd. (CSOT). In 2020, we entered into long-term, multi-year agreements with CSOT. Under these agreements, we have granted CSOT non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. We also supply phosphorescent OLED materials to CSOT for use in its licensed products.
In 2016, we acquired Adesis, Inc. (Adesis) which has operations in New Castle and Wilmington, Delaware. Adesis is a contract research organization (CRO) that provides support services to the OLED, pharma, biotech, catalysis and other industries. As of March 31, 2023, Adesis employed a team of 146 research scientists, chemists, engineers and laboratory technicians. Prior to our acquisition of Adesis, we utilized more than 50% of Adesis’ technology service and production output. We continue to utilize a significant portion of its technology research capacity for the benefit of our OLED technology development, and Adesis uses the remaining capacity to operate as a CRO in the above-mentioned industries by providing contract research services for non-OLED applications to those third-party customers. Contract research services revenue is earned by providing chemical materials synthesis research, development and commercialization for non-OLED applications on a contractual basis for those third-party customers.
In June 2020, a wholly-owned subsidiary, OVJP Corporation (OVJP Corp), was formed as a Delaware corporation. Based in California, OVJP Corp was founded to advance the commercialization of our proprietary Organic Vapor Jet Printing (OVJP) technology. As of March 31, 2023, OVJP Corp employed a team of 23 research, mechanical, electrical and software engineers and laboratory technicians. As a direct printing technique, OVJP technology has the potential to offer high deposition rates for large-area OLEDs. In addition, OVJP technology reduces OLED material waste associated with use of a shadow mask (i.e., the waste of material that deposits on the shadow mask itself when fabricating an OLED). By comparison to inkjet printing, an OVJP process does not use liquid solvents and therefore the OLED materials utilized are not limited by their viscosity or solvent solubility. OVJP also avoids generation of solvent wastes and eliminates the additional step of removing residual solvent from the OLED device. We believe the successful implementation
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of the OVJP technology has the potential to increase the addressable market for large-size OLED panels while also serving another potential growth market for our proprietary PHOLED materials and technologies.
In February 2021, we announced the establishment of a new manufacturing site in Shannon, Ireland and an agreement between UDC Ireland Limited and PPG for the production of our OLED materials. We currently lease the Shannon site and have a contractual option to purchase the facility. When fully operational, the new facility is expected to double our production capacity and allow for the diversification of our manufacturing base for phosphorescent emitters. The first phase of facility improvements has been completed and operations commenced in June 2022.
We also generate technology development and support revenue earned from development and technology evaluation agreements and commercialization assistance fees.
We anticipate fluctuations in our annual and quarterly results of operations due to uncertainty regarding, among other factors:
•the timing, cost and volume of sales of our OLED materials;
•the timing of our receipt of license fees and royalties, as well as fees for future technology development and evaluation;
•the timing and magnitude of expenditures we may incur in connection with our ongoing research and development and patent-related activities; and
•the timing and financial consequences of our formation of new business relationships and alliances.
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Further, we continue to monitor the impact of COVID-19 on our business. Our global operations, and the global nature of our customer base and their respective customers, expose us to risks associated with public health crises, such as pandemics, epidemics and disease outbreaks. The ongoing COVID-19 pandemic had a substantial impact on our operations and financial results during the year ended December 31, 2020 and continued to have a gradually lesser impact during the years ended December 31, 2021 and 2022 and the three months ended March 31, 2023. We expect that as the pandemic continues to evolve, there is the potential for continued impact on the results of our operations due to uncertainties involving the continued disruption of the global economy, uncertainties associated with consumer demand for finished OLED goods, and the potential resulting impact on our customers and their demand for our phosphorescent emitters.
At this time, the crisis has not had a significant impact on our ability to fulfill shipments of commercial materials as required by our customers.
We continue to actively monitor the COVID-19 situation and may take further actions that we determine are in the best interests of our employees, customers, partners, suppliers, and stakeholders, or as required by federal, state, or local authorities. It is not clear what effects any such potential actions could have on our business, including on our customers, employees, and financial results.
RESULTS OF OPERATIONS
Comparison of the Three Months Ended March 31, 2023 and 2022
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Three Months Ended March 31, |
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2023 |
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2022 |
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Increase (Decrease) |
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REVENUE: |
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Material sales |
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$ |
70,190 |
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$ |
86,691 |
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$ |
(16,501 |
) |
Royalty and license fees |
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55,210 |
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|
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59,802 |
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(4,592 |
) |
Contract research services |
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5,067 |
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|
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3,977 |
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|
|
1,090 |
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Total revenue |
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130,467 |
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150,470 |
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|
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(20,003 |
) |
COST OF SALES |
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32,970 |
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33,163 |
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(193 |
) |
Gross margin |
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97,497 |
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117,307 |
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(19,810 |
) |
OPERATING EXPENSES: |
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Research and development |
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31,423 |
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26,545 |
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4,878 |
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Selling, general and administrative |
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15,396 |
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21,062 |
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|
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(5,666 |
) |
Amortization of acquired technology and other intangible assets |
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2,891 |
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5,498 |
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(2,607 |
) |
Patent costs |
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2,255 |
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|
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1,798 |
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|
|
457 |
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Royalty and license expense |
|
|
164 |
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|
|
154 |
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|
10 |
|
Total operating expenses |
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52,129 |
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55,057 |
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|
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(2,928 |
) |
OPERATING INCOME |
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45,368 |
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|
|
62,250 |
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|
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(16,882 |
) |
Interest income, net |
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6,967 |
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|
|
291 |
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|
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6,676 |
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Other loss, net |
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(703 |
) |
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(34 |
) |
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(669 |
) |
Interest and other loss, net |
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6,264 |
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|
|
257 |
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|
|
6,007 |
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INCOME BEFORE INCOME TAXES |
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51,632 |
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62,507 |
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|
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(10,875 |
) |
INCOME TAX EXPENSE |
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(11,793 |
) |
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(12,537 |
) |
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|
744 |
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NET INCOME |
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$ |
39,839 |
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$ |
49,970 |
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|
$ |
(10,131 |
) |
Revenue
Our total material sales were $70.2 million for the three months ended March 31, 2023, as compared to $86.7 million for the three months ended March 31, 2022, a decrease of 19% with a commensurate decrease in unit material volume of 18%. The decline in material sales was primarily due to reduced demand for our emitter material. This weakness resulted from the continued unfavorable macroeconomic conditions that have negatively impacted the OLED display market segment. We believe the decline is temporary and that the duration is dependent upon the timing of the recovery of the global market conditions, which continues to be uncertain.
•Green emitter sales for the three months ended March 31, 2023, which include our yellow-green emitters, were $53.7 million as compared to $66.4 million for the three months ended March 31, 2022, with unit material volumes decreasing by 19%.
•Red emitter sales for the three months ended March 31, 2023 were $16.1 million as compared to $20.2 million for the three months ended March 31, 2022, with unit material volumes decreasing by 16%.
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Revenue from royalty and license fees was $55.2 million for the three months ended March 31, 2023 as compared to $59.8 million for the three months ended March 31, 2022, a decrease of 8%. The decrease in royalty and license fees was primarily the result of lower unit material volume.
The cumulative catch-up adjustment arising from changes in estimates of transaction price, net of $5.7 million for the three months ended March 31, 2023 resulted from an increase in the average price per gram that was primarily due to the decrease in anticipated demand by several of our customers over the remaining lives of their contracts, resulting from the continued deterioration in the global market economy as evidenced by weakness in consumer demand caused by higher interest rates and inflationary pricing pressures. At this time, substantial uncertainty exists as to the projected duration and intensity of this global market deterioration and the extent to which it will negatively impact such customers' near-term production requirements.
Contract research services revenue was $5.1 million for the three months ended March 31, 2023 as compared to $4.0 million for the three months ended March 31, 2022, an increase of 27%. Revenue from contract research services consists of revenue earned by our subsidiary, Adesis, which provides support services to the pharma, biotech, catalysis and other industries on a contractual basis for those third-party customers.
Cost of sales
Cost of sales for the three months ended March 31, 2023 decreased by $193,000 as compared to the three months ended March 31, 2022, primarily due to a decrease in the level of material sales, offset by an increase in manufacturing costs, underutilization of the manufacturing facility in Shannon, Ireland and higher per unit material costs. The underutilization charges related to the Shannon facility were $4.7 million for the three months ended March 31, 2023. Shannon facility costs began to be recorded as cost of sales in June 2022 when the facility was first used for production activities. Shannon facility costs prior to June 2022 were recorded in selling, general and administrative expenses. We anticipate that the Shannon facility will continue to be underutilized in the near-term as we have begun to bring this additional capacity online in preparation for anticipated growth in the years ahead. Included in the cost of sales for the three months ended March 31, 2023 and 2022 was an increase in inventory reserve of $3.3 million and $84,000, respectively, due to excess inventory levels in certain products. As a result of the decrease in revenue from material sales and royalty and license fees as well as the inventory reserve and Shannon costs, gross margin for the three months ended March 31, 2023 decreased by $19.8 million as compared to the three months ended March 31, 2022, with gross margin as a percentage of revenue decreasing to 75% from 78%.
Research and development
Research and development expenses increased to $31.4 million for the three months ended March 31, 2023, as compared to $26.5 million for the three months ended March 31, 2022. The increase in research and development expenses was primarily due to higher operating costs, including increased contract research and those associated with PPG development activity, and employee-related compensation expenses.
Selling, general and administrative
Selling, general and administrative expenses decreased to $15.4 million for the three months ended March 31, 2023, as compared to $21.1 million for the three months ended March 31, 2022. The decrease in selling, general and administrative expenses was primarily due to lower stock-based compensation expenses as a result of current assumptions of future vesting for performance-based awards and a decrease in pre-production costs associated with the Shannon facility. The Shannon facility became operational during June 2022 and the costs associated with this facility have since been included in cost of sales.
Amortization of acquired technology and other intangible assets
Amortization of acquired technology and other intangible assets was $2.9 million for the three months ended March 31, 2023, as compared to $5.5 million for the three months ended March 31, 2022. The decrease was due to the Fujifilm patents becoming fully amortized during July 2022.
Patent costs
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Patent costs increased to $2.3 million for the three months ended March 31, 2023, as compared to $1.8 million for the three months ended March 31, 2022. The results in the current year reflected higher internal prosecution related costs.
Royalty and license expense
Royalty and license expense increased to $164,000 for the three months ended March 31, 2023, as compared to $154,000 for the three months ended March 31, 2022.
Interest and other loss, net
Interest income, net was $7.0 million for the three months ended March 31, 2023, as compared to $291,000 for the three months ended March 31, 2022. The increase in interest income, net was primarily due to an increase in bond yields on available-for-sale investments held during the three months ended March 31, 2023 compared to the three months ended March 31, 2022 as well as higher available-for-sale investment balances. Other loss, net primarily consisted of net exchange gains and losses on foreign currency transactions and rental income. We recorded other loss, net of $703,000 for the three months ended March 31, 2023 as compared to $34,000 for the three months ended March 31, 2022.
Income tax expense
We are subject to income taxes in the United States and foreign jurisdictions. The effective income tax rate was an expense of 22.8% and 20.1% for the three months ended March 31, 2023 and 2022, respectively, and we recorded income tax expense of $11.8 million and $12.5 million, respectively, for those periods. The effective income tax rate increased due to a change in U.S. tax legislation associated with the ability to credit Chinese withholding taxes, as well as a change in the capitalization rules for research and development expenses.
Liquidity and Capital Resources
Our principal sources of liquidity are our cash and cash equivalents and short-term investments. As of March 31, 2023, we had cash and cash equivalents of $158.3 million, short-term investments of $487.8 million, and long-term corporate bonds and U.S. Government bonds investments of $199.3 million for a total of $845.4 million. This compares to cash and cash equivalents of $93.4 million, short-term investments of $484.3 million, and long-term U.S. Government bond investments of $247.9 million for a total of $825.6 million as of December 31, 2022.
Cash provided by operating activities for the three months ended March 31, 2023 was $47.6 million resulting from $39.8 million of net income, $5.1 million from non-cash items including depreciation, stock-based compensation and deferred income taxes and $2.7 million due to changes in our operating assets and liabilities. Changes in our operating assets and liabilities related to a decrease in other assets of $14.1 million, an increase in other liabilities of $12.3 million and a decrease in inventory of $9.0 million, partially offset by a decrease in accounts payable and accrued expenses of $24.1 million, a decrease in deferred revenue of $8.6 million, and an increase in accounts receivable of $13,000.
Cash provided by operating activities for the three months ended March 31, 2022 was $52.6 million resulting from $50.0 million of net income and $49.3 million due to changes in our operating assets and liabilities, partially offset by a $46.7 million reduction due to non-cash items including amortization of deferred revenue, stock-based compensation and amortization of intangibles. Changes in our operating assets and liabilities related to an increase in deferred revenue of $45.9 million, an increase in other liabilities of $8.2 million, a decrease in other assets of $6.0 million and a decrease in accounts receivable of $2.7 million, partially offset by an increase in inventory of $9.2 million and a decrease in accounts payable and accrued expenses of $4.3 million.
Cash provided by investing activities was $40.7 million for the three months ended March 31, 2023, as compared to $14.6 million for the three months ended March 31, 2022. The increase was due to the timing of maturities and purchases of investments resulting in net sales and maturities of $49.8 million for the three months ended March 31, 2023, as compared to $25.3 million for the three months ended March 31, 2022, partially offset by a decrease in purchases of property, plant and equipment and intangibles of $1.6 million.
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Cash used in financing activities was $23.4 million for the three months ended March 31, 2023, as compared to $21.7 million for the three months ended March 31, 2022. The increase was due to an increase in the cash payment of dividends in the current year of $2.5 million, partially offset by a decrease in the payment of withholding taxes related to stock-based compensation to employees of $715,000 and an increase in the proceeds from issuance of common stock of $115,000.
Working capital was $835.3 million as of March 31, 2023, as compared to $763.8 million as of December 31, 2022. The increase was primarily due to an increase in cash and cash equivalents and a decrease in accrued expenses, partially offset by an increase in other current liabilities.
We anticipate, based on our internal forecasts and assumptions relating to our operations (including, among others, assumptions regarding our working capital requirements, the progress of our research and development efforts, the availability of sources of funding for our research and development work, and the timing and costs associated with the preparation, filing, prosecution, maintenance, defense and enforcement of our patents and patent applications), that we have sufficient cash, cash equivalents and short-term investments to meet our obligations for at least the next twelve months.
We believe that potential additional financing sources for us include long-term and short-term borrowings and public and private sales of our equity and debt securities. It should be noted, however, that additional funding may be required in the future for research, development and commercialization of our OLED technologies and materials, to obtain, maintain and enforce patents respecting these technologies and materials, and for working capital and other purposes, the timing and amount of which are difficult to ascertain. There can be no assurance that additional funds will be available to us when needed, on commercially reasonable terms or at all, particularly in the current economic environment.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based on our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these Consolidated Financial Statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses, and other financial information. Actual results may differ significantly from our estimates under other assumptions and conditions.
We believe that our accounting policies related to revenue recognition and deferred revenue, inventories, and income taxes are our “critical accounting policies” as contemplated by the SEC.
Refer to our Annual Report on Form 10-K for the year ended December 31, 2022, for additional discussion of our critical accounting policies.
Contractual Obligations
Refer to our Annual Report on Form 10-K for the year ended December 31, 2022 for a discussion of our contractual obligations.
Off-Balance Sheet Arrangements
As of March 31, 2023, we had no off-balance sheet arrangements in the nature of guarantee contracts, retained or contingent interests in assets transferred to unconsolidated entities (or similar arrangements serving as credit, liquidity or market risk support to unconsolidated entities for any such assets), or obligations (including contingent obligations) arising out of variable interests in unconsolidated entities providing financing, liquidity, market risk or credit risk support to us, or that engage in leasing, hedging or research and development services with us.